If you’re buying an index fund or exchange-traded fund (ETF) that tracks a particular index, there are two main options you can choose.
An equal-weighted index fund is exactly that – a fund where all components (shares or bonds) are the same size.
Conversely, a market cap-weighted index fund allocates proportionately, so the larger companies’ stock or bonds make up a higher share of the index and the smaller companies’ stock or bonds comprise a smaller amount.
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If the point of an index fund is to have diverse exposure to lots of different companies (100 in the flagship FTSE index, 500 if it’s the US’s S&P equivalent and so on) then some might say using market capitalisation to allocate each component of the index seems a little short-sighted.
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If you’re a US index investor, buying a fund that tracks the S&P 500 index ought to give you access to 500 shares (it’s actually slightly over that – 505 at the end of July – because some companies, like Google’s parent Alphabet, list more than one share class of their stock). Yet the so-called Magnificent 7 (Mag 7) names account for around a third of the S&P’s value, with a combined market cap of around $22 trillion.
As a proxy for the wider US stock market, that concentration is reflective of the sector’s position in the market and role in the economy. But as an investment vehicle whose role is to give a one-stop shop to a diversified index, it raises the question of whether such an approach has some shortcomings.
Ultimately whether you favour one or other approach is a personal choice but there are arguments supporting both viewpoints.
Why does equal- versus market cap-weighted matter?
The main differences are about portfolio characteristics, rebalancing and performance.
When the Mag 7 were soaring, many investors might have welcomed their dominance. But now the performance of those stocks is slowing, it’s shining a light on the concentration risk they have presented.
According to ETF provider HANetf, all Mag 7 stocks have underperformed the index for the first time since 2022.
Mark Preskett, senior portfolio manager at Morningstar Wealth, said equal-weighted indices can look very different from market cap-weighted ones, with much lower tech exposure and more even allocation across the other sectors, such as healthcare, industrials, energy and financials. He added that they tilt away from megacap growth and towards a cheaper, less profitable part of the market.
The bigger a company becomes, the more of the index it comprises, inevitably attracting more money flows into it through the funds tracking the benchmark. In short, the winners keep getting bigger, because they are already the winners.
When those companies are outperforming, that makes for a strong investment case. But when things wobble, the opposite becomes true. This is referred to as concentration risk. A broad index may still contain hundreds of names but its performance depends on relatively few, large constituents.
The growth potential can vary sharply between the two strategies.
Morningstar compared its Global Target Market Exposure (TME) Equal Weighted index fund, which tracks gross returns of the top 85% largest mid- and large-cap global stocks (equal-weighted), in US dollars over 10 years (1 August 2016 to 1 August 2026). It took an initial value of $10,000, and with a cumulative return of 130.68%, turned that amount into $23,041.
The market cap-weighted peer generated a cumulative return of 224.68% over the same timeframe, turning $10,000 into $33,360.
This stark difference highlights the trade-off investors are making. Equal weighting can mean giving more exposure to mid-cap value characteristics and less to the megacap names driving the market-cap indices. But in the market cap-weighted index, its winners have generated significantly higher returns.
Rob Edwards, global head of product & research at Morningstar Indexes said this was not a new phenomenon. He pointed to long-run evidence that suggests a relatively small number of companies often drive returns.
A study by Hendrik Bessembinder from Arizona State University’s business school studied 29,754 stocks from 1926 to 2025, a time period over which $91 trillion of shareholder wealth was created. Just 46 companies accounted for half of that total wealth creation.
Yet Cameron MacDonald of HANetf said scepticism around artificial intelligence spending, a rotation into smaller companies and mixed recent results for the Mag 7 all support the case for equal weighting.
Citing FactSet data, Invesco (which also offers equal-weighted index strategies) pointed out that the equal-weight version of the S&P 500 index outperformed its market cap-weighted peer by an average of 1.05% annually between 1999 and 2023.
Benefits of equal weighting
If diversification is the point of investing in a broad index, then arguably the breadth of underlying company nuances is what you are seeking.
According to Morningstar, in the first quarter of the year, 65% of all European asset flows moved into passive funds, totalling €120 billion (£103 billion). With more money flowing into stocks via passive funds and exchange-traded funds (ETFs), there’s a risk that a market cap-weighted approach ends up rewarding the winners and inadvertently not backing the smaller companies (potentially the future winners) to the degree you might like to.
That is the argument made by proponents of equal-weighted funds. They give the smaller constituents a bigger role in the portfolio and reduce the influence of the biggest names. In practice, that often means less concentration in technology and more exposure to financials, healthcare, industrials and energy.
“You’re getting materially different outcomes and sector biases, about 10 times the market cap and almost a mid-cap value as a style rather than megacap growth”, said Preskett.
Further, those smaller stocks are cheaper; they have lower P/E multiples, lower price-to-book, but are often less profitable.
He does see how equal-weighted strategies can be used more tactically. “As markets got more concentrated [earlier this year] there seemed to be some more interest [by peers] in equally weighted portfolios. They were seen as a way of dialling down the risk, almost smoothing returns in a way as you’re bringing in a much more diversified subset.”
But beyond such tactical use, it wasn’t a long-term strategy his team would recommend for mainstream clients.
Edwards also said he disagreed with the idea that surging passive flows distorts long-term outcomes.
“I’m aware there’s been a narrative for academic summaries on this but I think in the long run, the reality is that if a company doesn’t have solid fundamentals, financials, growth characteristics, they're not going to keep growing.”
The winners are the winners because they have incredibly large moats; incredible scale, cost efficiencies, network effects of their businesses.
“Index construction plays very little part in terms of long-term share price growth. I don’t think you can point to index construction or the rise of passive investing because the reality is there's always going to be active management.”
Active management can play the role of countering the momentum when stocks get too expensive.
Ultimately the choice between equal- or market cap-weighted funds depends on what you want to achieve. They’re two very different strategies. To capture the market ‘as is’, market cap-weighting remains the default. If you’re hoping to reduce concentration and spread risk more evenly across the index, that makes a case for equal weighting.
